Bright lights, big numbers: the US jobs scene is beginning to post some blowout NFP prints again, but when will the Fed make its move? Photo: iStock

By Stephen Pope

Did Friday's US employment report represent a change in the topography of the US economy? After all, there had been a sequence of conflicting reports; remember the figure for May, when just 24,000 new jobs rolled down the pike!

The data set delivered by the Bureau of Labor Statistics marked the second consecutive month of vigorous hiring and rising wages, arguably sending a signal that the American economic expansion is strengthening as it enters its eighth year.

Source: BLS

US equity markets booked solid gains on the news with the Dow Jones up 0.84%, the S&P 500 up 0.77%, and the Nasdaq Composite up 1.08% as the market indicated its confidence that the Federal Reserve would raise interest rates before the end of the year.

The four-panel chart above clearly shows that the unemployment rate has fallen steadily and that job vacancies have moved in an improving, impulsive channel. However, I take heart from the left-hand panels revealing NFP gains and Average Hourly Earnings remain firmly in the upper section of their slow but steadily improving channels.

It is the AHE data that are most encouraging as in the US they increased 0.30% in July of 2016 over the previous month. AHE in the US averaged 0.20% from 2006 until 2016, reaching an all-time high of 0.60% in June of 2007 and a record low of minus 0.30% as recently as December of 2014.

This was a data set that delivered. It had gains on a broad basis with new entrants into the workplace. That points to an extension of the business cycle.

Political dimension

As both main American parties have completed their conventions the nation is slowly gearing up for the main showdown between Hillary Clinton (Democrat) and Donald Trump (Republican). This jobs report will be seen as bringing real comfort to the Clinton camp as it blunts Republican arguments that the recovery is faltering. It capped off what was bad week for the Republican standard-bearer.

The message is that following the deep declines after the financial crisis, the typical working family are at long last enjoying the benefits from the drop in unemployment, which was unchanged last month at a relatively low 4.9%.

Take home pay is up 2.6% over the past year so marking a more robust clip than was seen earlier in the recovery. Several economists expect that the gain in incomes, adjusted for inflation, will accelerate later this year and into 2017. So when the Republicans try to claim that the job market is ruined, their message is seen as just being incorrect.

The stalwarts of the Grand Old Party countered by suggesting that the July data was a simple snapshot, not any real marker for the general trend. Well, I think the four-panel chart negates that view. Another argument GOP put forward is that millions of Americans who dropped out of the work force during the recession have still not found jobs.

I would counter that by pointing out that the Labor Force Participation Rate increased to 62.8% in July from 62.7% in June and it averaged 63.0% from 1950 until 2016... so, not so badly out of line.

If Donald Trump is to make any headway on the economic front, he needs to focus on GDP. The economy grew at an annual rate of just 1.0% in H1 2016 marking a sharp decrease from last year. The GDP expanded 1.20% in Q2 2016 over the same quarter of the previous year, however. GDP annual growth rate averaged 3.21% from 1948 until 2016.

Source: Bureau of Economic Analysis

No uniform recovery

It cannot be denied that parts of the economy are still suffering from the ongoing fallout from low oil prices that has led many energy companies to reduce their investment programmes.

Crude prices are hovering near 11-year lows and so the world's biggest oil and gas producers are facing their longest period of investment cuts in decades.

At around $43/barrel, crude prices are well below the target price of $60/b that oil majors like BP, Chevron, Exxon, Total, and Statoil need if their books are to balance. Therefore, in an attempt to keep the accounts in order, costs have been cut so spending on exploration and research is slashed, assets are sold and jobs are cut. Projects, both upstream and downstream have been delayed time and time again.

Chevron and ConocoPhillips have published plans to slash their 2016 budgets by a quarter and Royal Dutch Shell announced a further $5 billion in spending cuts if its planned takeover of BG Group goes ahead.

Global oil and gas investments are expected to fall to their lowest in six years in 2016 to $522 Billion, following a 22% fall to $595 Billion in 2015, according to Rystad Energy a consultancy based in Oslo.

Oil prices remain a significant headwind for the US energy sector. Photo: iStock

In fact, the only thing on the up is borrowing so as to finance share buybacks and dividend payments.

Government spending in the US decreased to $290 trillion in Q2 2016 from $291.3 trillion in Q1. With a slowdown in government sub-contractor rates, many companies that count Uncle Sam as a major
customer seem at least for now to prefer to hire more workers rather than invest in new equipment and increase their efficiency and output.

I have noted before that a lack of productivity is America’s Achilles heel.

Janet’s judgement

The next twist in the fortune of the US economy will lay largely with the Fed. Yellen and the members of the FOMC will have noted that as well as July’s strong gains June was revised upward by 5,000 jobs, and May’s by 13,000.

This combination of better gains in the spring and July’s increase in hiring means that the Fed is likely to have a robust debate about (a) raising interest rates when it meets in September and (b) the timing of such a move.

The word on Wall Street is that the Fed would be best advised to hold its fire until December to be sure the economy remains on a solid track. The sentiment in the market for Fed Funds Futures gives just a 12% chance of a 25 basis points (bps) rate hike on September 21. On November 2 that moves to just 15.1%, although for December 14, the prospect of a rate increase jumps to 43.7%. I will point out though that the percentage odds of a rate hike do not run to over 50% until the meeting of March 15 next year.

The central bank is independent and so they will not be scared to move ahead of the election if such action were warranted, however December looks to be the favourite. The Fed will be cautious when it comes to raising short-term interest rates even though in July it said the economy was growing more strongly and there were fewer clouds on the horizon.

That clearly signalled it was giving greater consideration to rate increases later this year; for my money, the Fed will wait until December, before nudging the Fed Funds target toward 0.50% ~0.75%. That long lead in will be dollar-friendly and not spook equities prematurely.

The Fed are a central bank that can be ultra aggressive, e.g. the quick decisions by Bernanke to unleash waves of QE...or to taper. They also; perhaps more so with Yellen than BB can be typical of all central banks & exhibit caution.

I sense that the data in July was pleasing; various hawkish Fed Heads would argue for an earlier move. Certainly the comments on the economy pointed in that direction...but I think that that is it... they are handing out pointers to the market so as to avoid any spooked reaction to an early rate move. There is also a recognition that the global economy is in less than rude health & with the ECB holding steady with accommodation policies & BOE more than likely to drop Base Rates to 0.0% any hike in Fed Funds before December would be difficult for US exporters as the $ would soar. Economic team at Princeton have US export price elasticity of demand at -0.3%. When BOE cut Base DX rose 0.2%, so in theory US exports would fall 0.06%.

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